Tag Archives: london based insurers

In a previous post, I reproduced an exhibit from a report from Aon Benfield on the potential areas of disruption to extract expenses across the value chain in the non-life insurance sector, specifically the US P&C sector. The exhibit is again reproduced below.

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The diminishing returns in the reinsurance and specialty insurance sector are well known due to too much capital chasing low risk premia. Another recent report from Aon Benfield shows the sector trend in net income ROE from their market representative portfolio of reinsurance and specialty insurers, as below.

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It’s odd then in this competitive environment that the expense ratios in the sector are actually increasing. Expense ratios (weighted average) from the Willis Re sector representative portfolio, as below and in this report, illustrate the point.

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The 2016 edition of the every interesting S&P Reinsurance Highlights, as per this link, also shows a similar trend in expense ratios as well as showing the variance in ratios across different firms, as below.

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Care does need to be taken in comparing expense ratios as different expense items can be included in the ratios, some limit overhead expenses to underwriting whilst others include a variety of corporate expense items. One thing is clear however and that’s that firms based in the London market, particularly Lloyds’, are amongst the most top heavy in the industry. Albeit a limited sample, the graph below shows the extent of the difference of Lloyds’ and some of its peers in Bermuda and Europe.

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Digging further into expense ratios leads naturally to acquisitions costs such as commission and brokerage. Acquisition costs vary across business lines and between reinsurance and insurance so business mix is important. The graph below on acquisition costs again shows Lloyds’ higher than some of its peers.

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Although Brexit may only result in the loss of fewer than 10% of London’s business, any loss of diversification in this competitive market can impact the relevance of London as an important marketplace. Taken together with the gratuitous expense of doing business in London, its relevance may come under real pressure in the years to come. London is, most definitely, not calling.

Private equity is rushing to the exits in London with such sterling businesses as Poundland and Pets at Home coming to the market. PE has exited insurance investments, following the successful DirectLine float, for names like Esure, Just Retirement, and Partnership. It was therefore interesting to see Apollo and CVC refloat 25% of BRIT Insurance last week after taking them off the market just 3 short years ago.

The private equity guys made out pretty good. They bought BRIT in 2011 for £890 million, restructured the business & sold the UK retail business and other renewal rights, took £550 million of dividends, and have now floating 25% of the business at a value of £960 million. To give them their due, they are now committing to a 6 month lock-up and BRIT have indicated a shareholder friendly dividend of £75 million plus a special dividend if results in 2014 are good.

I don’t really know BRIT that well since they have been given the once over by Apollo/CVC. Their portfolio looks like fairly standard Lloyds of London business. Although they highlight that they lead 50% of their business, I suspect that BRIT will come under pressure as the trend towards the bigger established London insurers continues. Below is a graph of the tangible book value multiples, based off today’s price, against the average three year calendar year combined ratio.

As it has been almost 6 months until my last post on the tangible book value multiples for selected reinsurers and specialty insurers I thought it was an opportune time to post an update, as per graph the below.

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I tend to focus on tangible book value as I believe it is the most appropriate metric for equity investors. Many insurers have sub-debt or hybrid instruments that is treated as equity for solvency purposes. Although these additional buffers are a comfort to regulators, they do little for equity investors in distress.

In general, I discount intangible items as I believe they are the first thing that gets written off when a business gets into trouble. The only intangible item that I included in the calculations above is the present value of future profits (PVFP) for acquired life blocks of business. Although this item is highly interest rate sensitive and may be subject to write downs if the underlying life business deteriorates, I think they do have some value. Whether its 100% of the item is something to consider. Under Solvency II, PVFP will be treated as capital (although the tiering of the item has been the subject of debate). Some firms, particularly the European composite reinsurers, have a material amount (e.g. for Swiss Re PVFP makes up 12% of shareholders equity).

It’s been a great 12 months for wholesale insurers with most seeing their share price rise by 20%+, some over 40%. As would be expected, there has been some correlation between the rise in book values and the share price increase although market sentiment to the sector and the overall market rally have undoubtedly also played their parts. The graph below shows the movements over the past 12 months (click to enlarge).

The price to tangible book is one of my preferred indicators of value although it has limitations when comparing companies reporting under differing accounting standards & currencies and trading in different exchanges. The P/TBV valuations as at last weekend are depicted in the graph below. The comments in this post are purely made on the basis of the P/TBV metric calculated from published data and readers are encouraged to dig deeper.

I tend to look at the companies relative to each other in 4 broad buckets – the London market firms, the continental European composite reinsurers, the US/Bermuda firms, and the alternative asset or “wannabe buffet” firms. Comparisons across buckets can be made but adjustments need to be made for factors such as those outlined in the previous paragraph. Some firms such as Lancashire actually report in US$ as that is where the majority of their business is but trade in London with sterling shares. I also like to look at the relative historical movements over time & the other graph below from March 2011 helps in that regard.

Valuations as at March 2013 (click to enlarge):

Valuations as at March 2011(click to enlarge):

The London market historically trades at the highest multiples – Hiscox, Amlin, & Lancashire are amongst the leaders, with Catlin been the poor cousin. Catlin’s 2012 operating results were not as strong as the others but the discount it currently trades at may be a tad unfair. In the interest of open disclosure, I must admit to having a soft spot for Lancashire. Their consistent shareholder friendly actions result in the high historical valuation. These actions and a clear communication of their straight forward business strategy shouldn’t distract investors from their high risk profile. The cheeky way they present their occurrence PMLs in public disclosures cannot hide their high CAT exposures when the occurrence PMLs are compared to their peers on a % of tangible asset basis. Their current position relative to Hiscox and Amlin may be reflective of this (although they tend to go down when ex dividend, usually a special dividend!).

Within the continental European composite reinsurer bucket, the Munich and Swiss, amongst others, classify chunky amounts of present value of future profits from their life business as an intangible. As this item will be treated as capital under Solvency II, further metrics need to be considered when looking at these composite reinsurers. The love of the continental Europeans of hybrid capital and the ability to compare the characteristics of the varying instruments is another factor that will become clearer in a Solvency II world. Compared to 2011 valuations Swiss Re has been a clear winner. It is arguable that the Munich deserves a premium given it’s position in the sector.

The striking thing about the current valuations of the US/Bermudian bucket is how concentrated they are, particularly when compared to 2011. The market seems to be making little distinction between the large reinsurers like Everest and the likes of Platinum & Montpelier. That is surely a failure of these companies to distinguish themselves and effectively communicate their differing business models & risk profiles.

The last bucket is the most eccentric. I would class firms such as Fairfax in this bucket. Although each firm has its own twist, generally these companies are interested in the insurance business as the provider of cheap “float”, a la Mr Buffet, with the focus going into the asset side. Generally, their operating results are poorer than their peers and they have a liking for the longer tail business if the smell of the float is attractive enough (which is difficult with today’s interest rate). This bucket really needs to be viewed through different metrics which we’ll leave for another day.

Overall then, the current valuations reflect an improved sentiment on the sector. Notwithstanding the musings above, nothing earth shattering stands out based solely on a P/TBV analysis. The ridiculously low valuations of the past 36 months aren’t there anymore. My enthusiasm for the sector is tempered by the macro-economic headwinds, the overall run-up in the market (a pull-back smells inevitable), and the unknown impact upon the sector of the current supply distortions from yield seeking capital market players entering the market.

With many of the Bermudian, European and US wholesale insurers hitting 52 week highs last week, there is a definite shift in sentiment about the sector. It remains to be seen whether the shift is simply part of the overall market rally or a more structural shift in the markets view of the previously historic low tangible book multiples. A wide sample of firms in the reinsurance and wholesale insurance sectors are included in the graph below.

Disclaimer

This blog represents my personal views and is not reflective of the views or opinions held by any company or employer I work for currently or have worked for in the past. The views expressed herein are based solely upon publicly available data. No views expressed herein should be taken as an endorsement to take any particular course of action in the markets. The basis of this blog is that different views should be expressed and readers make up their own minds on the what they believe and act accordingly.